ConocoPhillips (COP) reported third-quarter 2011 adjusted earnings of $2.52 per share, comfortably beating the Zacks Consensus Estimate of $2.16. The earnings were also better than the year-earlier profit of $1.50.

The outperformance was mainly on the back of higher price realizations and better global refining margins, partially offset by lower upstream volumes as well as the absence of equity earnings from LUKOIL and higher taxes.

Revenues in the reported quarter jumped more than 28% year over year to $63.6 billion, but missed the Zacks Consensus Estimate of $68.1 billion.

Segmental Performance

Exploration and Production (E&P): The segment reported adjusted earnings of $2.2 billion during the quarter, reflecting an impressive 45.6% growth from the year-ago level of $1.5 billion. The improvement was aided by higher commodity prices, which were partially offset by higher taxes and lower volumes.

Daily production from the E&P segment averaged 1.54 million barrels of oil equivalent (MMBOE), down from 1.72 MMBOE in the year-ago quarter. The political unrest in Libya and suspended production in Bohai Bay were the dampeners.

While the company’s production declined, the impact on earnings was limited as it has shifted its focus toward higher margin production of oil sands, Lower 48 liquids and LNG (liquefied natural gas) production from North American natural gas. In the Exploration arena, ConocoPhillips continued to widen its worldwide shale position and also resumed deepwater Gulf of Mexico drilling activities.

Average realized price for liquids was $97.24 per barrel, compared with $69.45 in the year-earlier quarter. The price for natural gas was $5.45 per thousand cubic feet (Mcf) versus $4.80 realized in third quarter 2010.

Refining and Marketing: The segment recorded earnings of $1.2 billion compared with $268 million in the year-ago quarter. The upswing was attributable to improved refining margins worldwide.

Domestic refining crude oil capacity utilization rate in the quarter averaged 92%, in line with the year-ago quarter level. International capacity utilization rate averaged 93%, up significantly from 60% in the year-earlier quarter.

Midstream: The segment contributed $137 million to net income during the quarter, up substantially from the year-earlier level of $77 million, on account of improved natural gas liquids prices.

Chemicals: The segment recorded earnings of $197 million, up 49% from the year-ago level of $132 million, mainly on higher margins in ethylene.

Financials

During the quarter, ConocoPhillips generated $5.6 billion in cash from operations. As of September 30, 2011, the company had $3.4 billion cash balance and $23.2 billion in debt, with a debt-to-capitalization ratio of 26%.

The company repurchased 46 million shares, or 3% of shares outstanding, for $3.2 billion, bringing total shares repurchased to 12% of shares outstanding at the inception of the repurchase program in 2010. ConocoPhillips also paid $900 million in dividends and incurred $3.8 billion in capital expenditures.

Guidance

Fourth quarter production is expected in the range of 1.56–1.58 MMBoe/d, reflecting suspended operations in Bohai Bay and Libya. Full-year 2011 production is expected to be 1.61–1.62 MMBoe/d.

In February 2011, ConocoPhillips announced a capital budget program of $13.5 billion for 2011, 90% of which will be exhausted for exploration and development. The primary emphasis will be on the Eagle Ford Shale along with Permian, Bakken and Barnett Fields.

Further expenditures will be directed toward Canada (SAGD oil sands projects and Western Canada gas basins) and Alaska (Prudhoe Bay and Kuparuk Fields). Conoco plans to invest $14 billion to $15 billion per year from 2012 to 2015. Internationally, the primary emphasis will be on Australia followed by China and Poland.

Outlook

We remain optimistic on ConocoPhillips’ ability to generate free cash flow by unlocking capital tied up in non-core assets. The company also remains committed to its $15 billion to $20 billion 2010–2012 asset disposition program. Despite a production decline, upstream earnings increased year over year, boosted by strong realized pricing.

Again, we have a positive outlook on ConocoPhillips post split, as it holds the promise of unlocking significant value. The idea behind the spin-off is to create value for shareholders who like the volatility in the refining business.

Creation of two separate companies is also believed to be helpful as both entities will get to pursue greater opportunities in their respective market segments, without the constraints of the parent company, and better serve the needs of both investor groups. We expect this move to allow Conoco to narrow the return gap at which it historically lagged its peers.

ConocoPhillips’ exploration initiatives toward liquids rich plays such as Eagle Ford, Bakken and North Barnett shale plays are gaining momentum. Although we are encouraged by the recent discoveries and the company’s new exploration efforts as well as with a wider reserve base, production growth remains a long-term story.

Hence, we maintain our long-term Neutral recommendation on ConocoPhillips, the third-largest U.S. oil company by market value after ExxonMobilCorp. (XOM) and Chevron Corp. (CVX). Conoco holds a Zacks #3 Rank, which translates to a short term Hold rating.